Congressional Investigation, Bill Focus on Offshore Tax Havens

March 6, 2009

A key Senate investigative body this week continued its series of investigative hearings on offshore tax havens and tax abuse, focusing on the strict secrecy in which U.S. clients’ accounts and activities are maintained by Swiss financial institutions.  As part of this far-reaching investigation into alleged tax abuse, which is in its seventh year, the Senate Permanent Subcommittee on Investigations ("PSI") has focused on prominent offshore tax havens, dividend tax abuse, and a network of legal and financial advice that has allegedly allowed U.S. taxpayers to "hide" their assets offshore.  For a recap of earlier investigations by the subcommittee into alleged tax abuses, see our September 22, 2008 client alert

This most recent inquiry demonstrates that those businesses providing financial services to an international mix of clients can expect to come under the watchful eye of Congress.

As a result of his investigation, Senator Carl M. Levin (D-Mich.) has introduced legislation, the Stop Tax Haven Abuse Act (S. 506), which would make important changes to federal tax and anti-money laundering provisions.  Rep. Lloyd Doggett (D-Tex.) has introduced companion legislation in the House.

It is also clear that the seven-year investigation will continue.  In introducing S. 506, Senator Levin referenced a Government Accountability Office report on the subsidiaries of the 100 largest U.S. publicly-traded corporations that are located in tax haven countries.[1]  Levin noted that PSI "is currently engaged in an effort to understand why so many of these corporations have so many tax haven affiliates."[2]

March 4th Hearing

The subcommittee’s latest hearing, which was held on March 4, 2009, focused on recent developments with respect to bank secrecy.[3]  Of particular interest to the subcommittee is whether foreign financial institutions may be assisting U.S. clients in avoiding their tax obligations. 

Switzerland’s largest bank, UBS AG, was the latest target of PSI’s investigators, which previously focused on both UBS and Lichtenstein bank LGT as part of a July 2008 report.  In February, UBS admitted its role in helping U.S. citizens avoid their tax obligations, agreed to pay $780 million in fines to the U.S., and entered into a deferred prosecution agreement with the Department of Justice.  As part of that agreement, UBS agreed to reveal the names of approximately 250 U.S. clients.  Swiss law draws a distinction between actively engaging in tax fraud, which is prohibited, and the simple failure of U.S. clients to include a Swiss bank account as part of their U.S. tax returns, which is not a Swiss crime.  The identities of the 250 clients that UBS revealed to the U.S. government fell in the former category, and the Swiss government therefore permitted the disclosure.  Swiss law, however, does not permit the disclosure—and UBS refused to reveal—the identities of clients who may have simply omitted their Swiss bank accounts from U.S. tax returns.  On the day after the deferred prosecution agreement was signed, the Internal Revenue Service filed suit against UBS in federal district court to enforce "John Doe" summonses related to this latter category of accounts.  A hearing is scheduled in Miami for July 13, 2009.  Under the deferred prosecution agreement, UBS has preserved its right to challenge disclosure of customer identities relating to the "John Doe" summonses.  The agreement provides, however, that if UBS loses this case on appeal, it must either turn over additional information for the accounts or else the U.S. prosecution of UBS may resume. 

During this week’s hearing, Senator Levin and the subcommittee explored the extent of UBS’s cooperation with U.S. officials.  The subcommittee was principally focused on the fact that UBS has relied on Swiss law to resist complying with the "John Doe" summonses, reasoning that revealing their additional U.S. clients would violate the Swiss banking law and could subject their employees to criminal prosecution in Switzerland.  Much of Senator Levin’s criticism in this respect was directed at the standstill in negotiations between the U.S. and Switzerland regarding bank secrecy.  Pressure on Switzerland is coming from other quarters than the U.S.  When the G-20 meets in London on April 2, 2009, the issuance of an expanded "blacklist" of uncooperative tax havens is on the agenda.  This measure is reported to have the backing of France, Germany, and the United Kingdom.  In recent remarks, President Sarkozy did not rule out that Switzerland met the criteria to be included on the OECD’s list of Uncooperative Tax Havens.[4] 

Nevertheless, given that Swiss authorities refused to participate in this week’s hearing,[5] it is likely that firms such as UBS will continue to bear the brunt of PSI’s investigative oversight.  Moreover, it would be impossible to overstate the role played by the subcommittee in bringing the allegations against UBS to light.  As noted by Senator Levin, UBS’s first public admission that it had helped U.S. clients open Swiss accounts without disclosing their existence to the IRS came as part of the subcommittee’s July 2008 hearing.  Throughout the investigation, the subcommittee has uncovered and made public thousands of pages of internal UBS documents and UBS officials have been called to testify under oath before the subcommittee.  We fully expect similar investigations to continue in the months ahead as Senator Levin seeks to shore up support for the legislation he has introduced that targets international tax havens. 

Senator Levin has indicated that the subcommittee will continue to focus on corporations and firms with operations in offshore tax havens. 

Legislation Introduced

Senator Levin, along with Senators Claire McCaskill (D-Mo.), Sheldon Whitehouse (D-R.I.), Bill Nelson (D-Fla.), and Jeanne Shaheen (D-N.H.), recently introduced the Stop Tax Haven Abuse Act of 2009.  This bill is an updated version of legislation originally introduced in 2007 and which was co-sponsored by then-Senator Obama; a companion bill has been introduced in the House by Rep. Lloyd Doggett (D-Tex.).[6]  During the March 4th hearing, Senator Levin referenced the support of both President Obama and Treasury Secretary Tim Geithner for his new bill.  Then-Senator Obama was a co-sponsor of the Levin bill in the 110th Congress and Secretary Geithner expressed explicit support for the measure in response to a question from Rep. Doggett during a House Ways and Means hearing earlier this week.

Senator Levin’s bill, which "offers powerful new tools to detect and stop offshore tax offenders," would make significant changes to federal tax and anti-money laundering ("AML") provisions.[7]  Significantly, Section 101 of the bill would provide an initial list of 34 "Offshore Secrecy Jurisdictions," including Switzerland, which the Secretary of the Treasury would have the discretion to add to or subtract from in light of criteria specified in the bill.  Senator Levin has also targeted the use of what he has referred to as "phony offshore shell corporations," referring recently to the large number of publicly traded U.S. corporations with subsidiaries in tax haven jurisdictions.  In that regard, Section 101 of the bill creates a number of rebuttable legal presumptions that would apply to non-publicly traded entities in "Offshore Secrecy Jurisdictions."  These presumptions would govern in tax and securities proceedings related to the control, transfer, and beneficial ownership of assets in Offshore Secrecy Jurisdictions. 

In addition, section 102 would amend the so-called "Special Measures" provision that was added to the Bank Secrecy Act by the USA PATRIOT Act.[8]  This provision, which authorizes the Secretary of the Treasury to designate certain foreign jurisdictions, financial institutions, or financial transactions to be of "primary money laundering concern,"  would be amended to permit the Secretary to designate jurisdictions, financial institutions, and transactions that "impede United States tax enforcement."  The range of special measures that could be imposed upon a finding of primary money laundering concern or a finding of impeding tax enforcement would also be expanded.  Potential special measures would include prohibiting approval or use in the U.S. of credit and debit cards by U.S. financial institutions or credit card companies if the card involved a designated jurisdiction, financial institution, or prohibited type of transaction conducted using the card.  For example, a special measure could prohibit the use of credit cards issued by banks in tax haven jurisdictions that cater to U.S. tax evaders.  Indeed, issuing credit cards to U.S. cardholders who fund their credit card purchases with untaxed funds has previously been identified as a tax abuse.

Tax-Related Provisions

There are a variety of tax provisions in the bill that broadly target foreign activities of U.S. persons.  The provisions generally fall into three categories: expanding the tax reach of the U.S. over such foreign activities; increasing reporting obligations; and imposing additional restrictions on the provision of tax advice.  Most of these proposals carry over from a similar bill Levin introduced in 2007, but a few new items have been added to the current version.  At this point, it is unclear whether any of the proposals would be included in other legislation if this bill does not move forward.

Most of the substantive tax provisions appear to be very targeted responses to specific arrangements that have been viewed as abusing "loopholes" in the Code. Among the more notable provisions is a provision that would treat certain large foreign corporations as domestic corporations if they are managed from within the U.S. This provision would target U.S. public companies that have reincorporated offshore while retaining their management in the U.S., and  would likely affect a number of offshore investment vehicles, such as hedge fund or private equity fund entities. Another provision would impose a tax on certain payments made pursuant to derivatives designed to mimic dividend payments. The bill would also effectively subject certain foreign trusts to U.S. taxation.

A number of the proposals have received significant criticism in the past.  The attempt to codify the "economic substance doctrine," for example, has been proposed numerous times over the past decade and is included again here.  However, it has had difficulty gaining any traction, as it has been almost universally panned by the tax bar, as well as the IRS, as having a chilling effect on legitimate transactions and having the potential of becoming a source of further abuse.  Some commentators see proposals such as the one to tax certain foreign corporations as domestic corporations as likely to be ineffective or deter foreign investment in the U.S. 

Likewise, prior legislation and regulations imposing reporting obligations and sanctions on advisors have been viewed by practitioners as interfering with traditional attorney-client relationships, hindering the provision of tax advice, and greatly increasing the costs of obtaining tax counsel.  Indeed, several previous attempts to target "abusive" tax advice were met with such strong resistance that the rules were quickly liberalized by subsequent legislation or rulemaking.

Provisions Relating to Money Laundering

Section 105 of the bill would expand the reporting obligations of U.S. persons and other "withholding agents" to include certain situations in which the withholding agent has custody or control of an amount constituting U.S. source income of a foreign entity (other than a publicly traded entity) and the agent determines that a U.S. person is a beneficial owner of the foreign entity.   Further, it would require financial institutions directly or indirectly opening accounts or forming or acquiring entities (other than publicly traded entities) in the specified tax haven jurisdictions to report such activities if done at the direction of, on behalf of, or for the benefit of a U.S. person.  In introducing the bill, Senator Levin noted that as part of its anti-money laundering due diligence, a financial institution should know if a customer that is a foreign legal entity is owned by a U.S. person, but that the financial institution may currently not be required to file a Form 1099 on the foreign legal entity which may not be considered a US taxpayer.  The bill would also require financial institutions to file an information return when they open accounts or form legal entities in "an offshore secrecy jurisdiction" at the direction of, on behalf of, or for the benefit of a U.S. person.  

Section 202 sets a deadline for the Department of the Treasury, in consultation with the SEC, to promulgate regulations under the Bank Secrecy Act requiring unregistered investment funds, including hedge funds and private equity funds, to implement AML programs and to file suspicious activity reports with Treasury.  Senator Levin was highly critical of the withdrawal last fall by the Department of the Treasury’s Financial Crimes Enforcement Network ("FinCEN") of a 2002 notice of proposed rulemaking which would have required AML programs for certain unregistered investment companies.  Under section 202, Treasury would be required to propose these regulations within 90 days of enactment of the bill and publish a final rule with 180 days.  There is no deadline for the effective date of the final rule, however.[9]  

Section 202 also amends the list of businesses defined as "financial institutions" under the Bank Secrecy Act[10] to include company formation agents, i.e., "persons involved in forming new corporations, limited liability companies, partnerships, trusts or other legal entities."  In addition, Treasury is required, after consultation with the Department of Justice, IRS, and the SEC, to promulgate regulations requiring AML programs under the same deadlines as for unregistered investment company regulations.  On its face, the definition does not exclude lawyers.  In his remarks, Senator Levin said that the regulatory requirements would reach  company formation agents outside the U.S.  The authority to apply the BSA extraterritorially is questionable.  


We will continue to monitor these legislative developments closely. In the meantime, we expect Senator Levin and the subcommittee to continue to investigate firms with operations in offshore tax havens as part of the process of building public support for his bill. Notwithstanding the bill’s endorsement by the Administration and the Administration’s inclusion of a placeholder for "international enforcement" in its budget submission, the measure’s chances of passage are uncertain. At this point, the Senate bill does not have any Republican co-sponsors. Nor, to our knowledge, has it been scored by the Joint Committee on Taxation, so it is not possible to determine how attractive an offset it could be for tax relief or mandatory spending increases. Finally, Senator Levin introduced a similar measure in the 110th Congress and it was not taken up by the Finance Committee. 

Senator Levin’s bill bears watching, as does the future direction of PSI’s tax haven investigation. As with all Congressional investigations, firms facing investigation by Congress should adequately prepare by appreciating the unique nature of a Congressional inquiry. Firms should also know that the subcommittee’s investigation into tax abuse is a long-standing pursuit, and one in which the subcommittee has not hesitated to use its subpoena power. Firms that are subject to the subcommittee’s investigative jurisdiction should anticipate that they may be called to account for their business practices, marketing literature, and internal documents. Moreover, representatives of firms targeted by PSI can expect to be called to testify as part of a public hearing. The powerful investigative reach of congressional committees can have significant legal and business consequences for the companies that are targeted.  

  [1]   GAO, "Large U.S. Corporations and Federal Contractors with Subsidiaries in Jurisdictions Listed as Tax Havens or Financial Privacy Jurisdictions" (Dec. 2008),

  [2]   155 Cong. Rec. S2626 (daily ed. Mar. 2, 2009) (statement of Sen. Levin).

  [3]   For a video of the subcommittee’s hearing and other materials, see

  [4]   The OECD list, which contained 35 names at its inception in 2000, is down to Andorra, Monaco, and Lichtenstein.  Switzerland, as an OECD member, was never on the list.

  [5]   "Swiss Bank Miss,” Wall Street Journal (Feb. 27, 2009),

  [6]   See Senator Carl M. Levin, Summary of Stop Tax Haven Abuse Act (Mar. 2, 2009),

  [7]   Statement of Senator Carl Levin on Tax Haven Banks and U.S. Tax Compliance (Mar. 4, 2009),

  [8]   31 U.S.C. § 5318A. 

  [9]   A provision setting a deadline for unregistered investment company AML programs and suspicious activity reporting regulations also is contained in the Hedge Funds Transparency Act of 2009, which is pending in the Senate.

[10]   31 U.S.C. § 5312(a)(2).

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